personal finance

Calculate your personal inflation basket


One of the most common issues that crops up with clients, even above and beyond the complexity of pension schemes, is the lack of a financial plan.

I meet many people who save, but when I ask what they’re saving for, they give very generic answers: schools fees, children, retirement, or “because I should”.

It’s not just out of pedantry that I press on, or even a burning desire to know whether their retirement plans involve lots of golf, travelling, or whittling flutes. But each of these activities has its own annual cost, to a greater or lesser extent. If you don’t have a goal, you’ll never get there. You know the old saying — fail to plan, plan to fail.

In order to work out how much is needed to retire on, I encourage clients to think about how much money they spend each weekend. For most of us, it will be far more than we spend during the week. Unless your retirement plans involve locking yourself in a cupboard for 10 hours a day, five days a week, you need to give it some thought.

Of course in retirement, you hopefully won’t be paying a mortgage, won’t need to save any more, pay for a costly commute and the kids should be off your hands. While everyone will have their own number, let’s assume you need to generate an income of £2,000 per month net of fees and taxes from the age of 60.

However, that figure is today’s. I am 43, so assuming consumer price index inflation, currently 2.3 per cent, that takes me to just under £3,000 per month at 60. Einstein reputedly said that compounding was the eighth wonder of the world, but when it comes to the compounding of inflation, it can be a frightening and a chastening experience.

You may wonder why I am assuming CPI and not RPI (retail prices index), currently rather higher at 3.2 per cent. While I’m sure readers of the FT know the difference, for my own part I think the CPI represents a wider selection of goods and services. It also doesn’t include mortgages, which hopefully I will be free of once I retire.

But before we get too carried away with those CPI figures, it’s worth remembering that this measure is also far from ideal. The “basket” of goods and services used to calculate CPI changes all the time to better reflect the cost of living.

It surprised me to learn that the cost of bouncing a cheque was only removed in 2017. In an effort to keep up with events, the basket now includes the price of a “soft play” session, private school fees and long-term care fees. There’s also medium density fibreboard (MDF) and liver.

Why do we need such a spread? Because this is not your personal basket of goods and services — it is the nations. Liver-devouring or not, we are all wonderfully different, and the basket needs to be representative.

It’s dull but sensible, but everyone should start a spreadsheet of their own spending habits. You can use the data to compile your own personal inflation basket, swapping items in and out over time that are relevant. You will also be able to track your changing spending patterns, and changes to the goods and services you always buy.

It’s up to you how granular you want to be. You might want to record buying a packet of chopped liver at the butcher; personally, I find it easier to track the overall cost of the weekly grocery shop. But you might want to give luxury items, such as fine wines, their own category.

This is not intended to curb your spending — you should keep spending as you wish, and enjoy. This is just to track it, and help you plan better for the future. It will also show how competitive your goods are. Patterns in your personal spending data will highlight whether the retailers you shop at take you for granted, or whether they are fighting for your business. This makes a massive difference to the price of your goods.

So what does all this mean? In essence, no one wants to be saving all these years for something based on a flawed set of assumptions. Let’s say you get to 60 and discover your personal inflation rate is 6 per cent. That changes my original assumption of £2,000 per month to more than £5,000.

And remember, inflation doesn’t stop when you retire. If you’ve made the wrong assumptions, there is little you can do aged 60 apart from curbing your spending, working for longer or taking more investment risk than you had planned, or with which you are comfortable. Not a very relaxing retirement. So have an audit of your bank statements (you can often export these as a spreadsheet), your wardrobe, garage and fridge, and start the spreadsheet.

You should keep running this for at least four years into retirement, so you are confident that your figures are correct. You will be amazed that there is an extraordinary item almost every month. But by then, this will not be extraordinary for you, as you have assumed its occurrence.

When you are confident of your personal inflation rate, you can work out the risk you need to take with your pension and retirement funds to target a personal return.

On a more positive side, once I have worked with a client for a number of years, we more often than not get to a point where I can tell them that not only do they have enough money for the rest of their lives, but can dramatically increase their annual expenditure.

Yet in such cases, these people never increase their expenditure significantly. The reason is that by nature they are savers, they are happy with their lives, and spending more does not necessarily mean they will be happier.

So if you are not going to a MDF and liver party this weekend (although let me know if you are), see if you can carve out a few hours to start tracking your numbers, making your own assumptions and building your own financial plan.

Failure to do so might leave you short in the final years, where the long term care home fees become relevant and vital. Come retirement, the last thing you want to see in your personal inflation basket is the cost of a bouncing cheque.

Michael Martin is a relationship manager at Seven Investment Management. The views expressed are personal. Twitter: @7IM_MichaelM





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